Moderation in earnings growth may weigh on equities this year: Vinit Sambre

As stock prices continue to soar, the market may be entering the excessive valuation zone, says Vinit Sambre, head of equities at DSP Mutual Fund. In an email interview with Abhishek Kumar, Sambre says while equities may do well in the long term, it would be prudent for investors to reassess their asset allocation and bring it in line with their risk profile. Edited excerpts:

How do you see the market positioned at this juncture? What is your outlook, considering the valuations and earnings growth expectations?

After enduring a decade of lacklustre single-digit earnings growth from FY10 to FY20, there was a notable inflection point during FY21 to FY23, characterised by robust double-digit growth. On the back of this performance, the market has been on a sustained bull run. As a result, valuations have risen above the 10-year averages, particularly in the mid and smallcap segments. Going forward, we anticipate a moderation in growth over the next 2-3 quarters, potentially leading to some consolidation or even a market downturn. Moreover, there appears to be unwarranted optimism surrounding low-quality or cyclically-sensitive businesses within the smallcap space.

What are the key headwinds for this year? 

One of the foremost challenges lies in the deceleration of consumption among the lower strata of society, coupled with geopolitical tensions that are disrupting supply chains. These supply chain disruptions have the potential to sustain high inflation levels, contrary to expectations, thus dampening hopes for a swift decrease in interest rates. Moreover, persistently high interest rates could impede global economic momentum, consequently impacting India's growth prospects to a certain degree.

Has the sharp rally in the smallcap space resulted in any change in strategy or portfolio composition in the last one year?

In the DSP Smallcap Fund, we consistently seek out businesses capable of surpassing broader corporate growth rates and have strong governance structures, ability to achieve return on capital employed (RoCE) exceeding 16 per cent, positive cash flow generation, and low leverage. Over the past year, we have increased our exposure to companies poised to benefit from government capex, as well as healthcare and smallcap IT firms undergoing transition. Furthermore, we are closely monitoring the consumption space, which is currently experiencing a slowdown. Should stocks in this sector reach attractive valuations, we would consider increasing our exposure.

What is your recommendation to investors, both from asset allocation as well as fund selection point of view?

With stock prices soaring, we may be entering an excessive zone in terms of valuations, prompting a need for caution. While our overall outlook on equities remains positive in the long term, it would be prudent for investors to periodically reassess their asset allocation and maintain a balanced portfolio across various categories based on their risk-return profiles. For conservative investors, now could be an opportune moment to rebalance their portfolios if they've become skewed towards riskier assets.

Your allocation towards pharma stocks is on the higher side. What makes you bullish on this sector? 

The pharma sector experienced notable underperformance from early 2021 to mid-2023, mostly due to margin compression. Additionally, pricing pressures in the US market intensified due to heightened competition. However, things have now changed on both fronts. Costs have started to moderate and pricing pressures in the US market have subsided. The valuation is also reasonable, when compared to the broader market. 

One key change the market is expecting in 2024 is that growth style investing may make a comeback. What is your view?

I see the labels of growth and value as mere distinctions without significant meaning. Regardless of whether a stock is classified as growth or value, its performance is typically driven by specific triggers. Over the past two years, stocks traditionally labelled as value, such as PSU banks and PSU power utilities, have witnessed inflections in their earnings and return on equity (RoE), resulting in commendable performance. Therefore, our portfolio strategy revolves around analysing shifts in business cycles. Currently, we have an overweight position in auto, banking, and healthcare sectors.